Statement of Financial Accounting Concepts No.

As Amended

August 2018

Conceptual Framework for Financial Reporting

Chapter 3, Qualitative Characteristics of Useful
Financial Information

a replacement of FASB Concepts Statements No. 1 and No. 2

Copyright © 2018 by Financial Accounting Foundation. All rights reserved.
Content copyrighted by Financial Accounting Foundation may not be
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 Statement of
Financial Accounting Concepts No. 8

As Amended

August 2018

Conceptual Framework for Financial Reporting

Chapter 3, Qualitative Characteristics of Useful
Financial Information

a replacement of FASB Concepts Statements No. 1 and No. 2

Financial Accounting Standards Board

401 MERRITT 7, PO BOX 5116, NORWALK, CONNECTICUT 06856-5116
Statement of Financial Accounting Concepts No. 8

As Amended

Conceptual Framework for Financial Reporting

August 2018

CONTENTS
Paragraph
Numbers
Chapter 3: Qualitative Characteristics of Useful Financial
Information ......................................................................................... QC1–QC39
Introduction ..................................................................................... QC1–QC3
Qualitative Characteristics of Useful Financial Information ........... QC4–QC34
Fundamental Qualitative Characteristics................................ QC5–QC18
Relevance ....................................................................... QC6–QC11
Materiality ........................................................... QC11–QC11B
Faithful Representation ................................................. QC12–QC16
Applying the Fundamental Qualitative
Characteristics ............................................................ QC17–QC18
Enhancing Qualitative Characteristics ................................. QC19–QC34
Comparability ................................................................ QC20–QC25
Verifiability .................................................................... QC26–QC28
Timeliness................................................................................ QC29
Understandability .......................................................... QC30–QC32
Applying the Enhancing Qualitative Characteristics ...... QC33–QC34
The Cost Constraint on Useful Financial Reporting .................... QC35–QC39
Appendix: Basis for Conclusions for Chapter 3 ............................... BC3.1–BC3.48
Introduction ................................................................................ BC3.1–BC3.3
Background .....................................................................................BC3.3
The Objective of Financial Reporting and the Qualitative
Characteristics of Useful Financial Information ........................ BC3.4–BC3.7
Fundamental and Enhancing Qualitative Characteristics ......... BC3.8–BC3.43
Fundamental Qualitative Characteristics......................... BC3.11–BC3.31
Relevance ................................................................ BC3.11–BC3.18
Predictive and Confirmatory Value ................... BC3.14–BC3.15
The Difference between Predictive Value and
Related Statistical Terms ..............................................BC3.16
 Paragraph
Numbers

Materiality ...................................................... BC3.17–BC3.18D

Faithful Representation ............................................ BC3.19–BC3.31
Replacement of the Term Reliability ................. BC3.20–BC3.25
Substance over Form .....................................................BC3.26
Prudence (Conservatism) and Neutrality .......... BC3.27–BC3.29
Can Faithful Representation Be Empirically
Measured? ...................................................... BC3.30–BC3.31
Enhancing Qualitative Characteristics ............................ BC3.32–BC3.43
Comparability ........................................................... BC3.32–BC3.33
Verifiability ............................................................... BC3.34–BC3.36
Timeliness................................................................ BC3.37–BC3.39
Understandability ..................................................... BC3.40–BC3.43
Qualitative Characteristics Not Included ................................ BC3.44–BC3.46
The Cost Constraint on Useful Financial Reporting.............. BC3.47–BC3.48
Statement of Financial Accounting
Concepts No. 8
As Amended
Conceptual Framework for Financial
Reporting
CHAPTER 3: QUALITATIVE CHARACTERISTICS OF
USEFUL FINANCIAL INFORMATION

Introduction
QC1. The qualitative characteristics of useful financial information discussed
in this chapter identify the types of information that are likely to be most useful to
the existing and potential investors, lenders, and other creditors for making
decisions about the reporting entity on the basis of information in its financial report
(financial information).
QC2. Financial reports provide information about the reporting entity’s
economic resources, claims against the reporting entity, and the effects of
transactions and other events and conditions that change those resources and
claims. (This information is referred to in the Conceptual Framework as information
about the economic phenomena.) Some financial reports also include explanatory
material about management’s expectations and strategies for the reporting entity
and other types of forward-looking information.
QC3. The qualitative characteristics of useful financial information 1 apply to
financial information provided in financial statements, as well as to financial
information provided in other ways. Cost, which is a pervasive constraint on the
reporting entity’s ability to provide useful financial information, applies similarly.
However, the considerations in applying the qualitative characteristics and the cost
constraint may be different for different types of information. For example, applying
them to forward-looking information may be different from applying them to
information about existing economic resources and claims and to changes in those
resources and claims.

1
Throughout this Conceptual Framework, the terms qualitative characteristics and constraint
refer to the qualitative characteristics of, and the constraint on, useful financial information.

1
Qualitative Characteristics of Useful Financial Information
QC4. If financial information is to be useful, it must be relevant and faithfully
represent what it purports to represent. The usefulness of financial information is
enhanced if it is comparable, verifiable, timely, and understandable.

Fundamental Qualitative Characteristics

QC5. The fundamental qualitative characteristics are relevance and faithful
representation.

Relevance
QC6. Relevant financial information is capable of making a difference in the
decisions made by users. Information may be capable of making a difference in a
decision even if some users choose not to take advantage of it or already are
aware of it from other sources.
QC7. Financial information is capable of making a difference in decisions if it
has predictive value, confirmatory value, or both.
QC8. Financial information has predictive value if it can be used as an input
to processes employed by users to predict future outcomes. Financial information
need not be a prediction or forecast to have predictive value. Financial information
with predictive value is employed by users in making their own predictions.
QC9. Financial information has confirmatory value if it provides feedback
(confirms or changes) about previous evaluations.
QC10. The predictive value and confirmatory value of financial information are
interrelated. Information that has predictive value often also has confirmatory
value. For example, revenue information for the current year, which can be used
as the basis for predicting revenues in future years, also can be compared with
revenue predictions for the current year that were made in past years. The results
of those comparisons can help a user to correct and improve the processes that
were used to make those previous predictions.

Materiality

QC11. Relevance and materiality are defined by what influences or makes a

difference to an investor or other decision maker; however, the two concepts can
be distinguished from each other. Relevance is a general notion about what type
of information is useful to investors. Materiality is entity specific. The omission or
misstatement of an item in a financial report is material if, in light of surrounding
circumstances, the magnitude of the item is such that it is probable that the

2
judgment of a reasonable person relying upon the report would have been
changed or influenced by the inclusion or correction of the item.
QC11A. A decision not to disclose certain information or recognize an economic
phenomenon may be made, for example, because the amounts involved are too
small to make a difference to an investor or other decision maker (they are
immaterial). However, magnitude by itself, without regard to the nature of the item
and the circumstances in which the judgment has to be made, generally is not a
sufficient basis for a materiality judgment.
QC11B. No general standards of materiality could be formulated to take into
account all the considerations that enter into judgments made by an experienced,
reasonable provider of financial information. That is because materiality judgments
can properly be made only by those that understand the reporting entity’s pertinent
facts and circumstances. Whenever an authoritative body imposes materiality
rules or standards, it is substituting generalized collective judgments for specific
individual judgments, and there is no reason to suppose that the collective
judgments always are superior.

Faithful Representation
QC12. Financial reports represent economic phenomena in words and
numbers. To be useful, financial information not only must represent relevant
phenomena, but it also must faithfully represent the phenomena that it purports to
represent. To be a perfectly faithful representation, a depiction would have three
characteristics. It would be complete, neutral, and free from error. Of course,
perfection is seldom, if ever, achievable. The Board’s objective is to maximize
those qualities to the extent possible.
QC13. A complete depiction includes all information necessary for a user to
understand the phenomenon being depicted, including all necessary descriptions
and explanations. For example, a complete depiction of a group of assets would
include, at a minimum, a description of the nature of the assets in the group, a
numerical depiction of all of the assets in the group, and a description of what the
numerical depiction represents (for example, original cost, adjusted cost, or fair
value). For some items, a complete depiction also may entail explanations of
significant facts about the quality and nature of the items, factors and
circumstances that might affect their quality and nature, and the process used to
determine the numerical depiction.
QC14. A neutral depiction is without bias in the selection or presentation of
financial information. A neutral depiction is not slanted, weighted, emphasized,
deemphasized, or otherwise manipulated to increase the probability that financial
information will be received favorably or unfavorably by users. Neutral information
does not mean information with no purpose or no influence on behavior. On the
contrary, relevant financial information is, by definition, capable of making a
difference in users’ decisions.

3
QC15. Faithful representation does not mean accurate in all respects. Free
from error means there are no errors or omissions in the description of the
phenomenon, and the process used to produce the reported information has been
selected and applied with no errors in the process. In this context, free from error
does not mean perfectly accurate in all respects. For example, an estimate of an
unobservable price or value cannot be determined to be accurate or inaccurate.
However, a representation of that estimate can be faithful if the amount is
described clearly and accurately as being an estimate, the nature and limitations
of the estimating process are explained, and no errors have been made in
selecting and applying an appropriate process for developing the estimate.
QC16. A faithful representation, by itself, does not necessarily result in useful
information. For example, a reporting entity may receive property, plant, and
equipment through a government grant. Obviously, reporting that an entity
acquired an asset at no cost would faithfully represent its cost, but that information
probably would not be very useful. A slightly more subtle example is an estimate
of the amount by which an asset’s carrying amount should be adjusted to reflect
an impairment in the asset’s value. That estimate can be a faithful representation
if the reporting entity has applied properly an appropriate process, described
properly the estimate, and explained any uncertainties that significantly affect the
estimate. However, if the level of uncertainty in such an estimate is sufficiently
large, that estimate will not be particularly useful. In other words, the relevance of
the asset being faithfully represented is questionable. If there is no alternative
representation that is more faithful, that estimate may provide the best available
information.

Applying the Fundamental Qualitative Characteristics

QC17. Information must be both relevant and faithfully represented if it is to be
useful. Neither a faithful representation of an irrelevant phenomenon, nor an
unfaithful representation of a relevant phenomenon, helps users make good
decisions.
QC18. The most efficient and effective process for applying the fundamental
qualitative characteristics usually would be as follows (subject to the effects of
enhancing characteristics and the cost constraint, which are not considered in this
example). First, identify an economic phenomenon that has the potential to be
useful to users of the reporting entity’s financial information. Second, identify the
type of information about that phenomenon that would be most relevant if it is
available and can be faithfully represented. Third, determine whether that
information is available and can be faithfully represented. If so, the process of
satisfying the fundamental qualitative characteristics ends at that point. If not, the
process is repeated with the next most relevant type of information.

4
Enhancing Qualitative Characteristics
QC19. Comparability, verifiability, timeliness, and understandability are
qualitative characteristics that enhance the usefulness of information that is
relevant and faithfully represented. The enhancing qualitative characteristics also
may help determine which of two ways should be used to depict a phenomenon if
both are considered equally relevant and faithfully represented.

Comparability
QC20. Users’ decisions involve choosing between alternatives, for example,
selling or holding an investment, or investing in one reporting entity or another.
Consequently, information about a reporting entity is more useful if it can be
compared with similar information about other entities and with similar information
about the same entity for another period or another date.
QC21. Comparability is the qualitative characteristic that enables users to
identify and understand similarities in, and differences among, items. Unlike the
other qualitative characteristics, comparability does not relate to a single item. A
comparison requires at least two items.
QC22. Consistency, although related to comparability, is not the same.
Consistency refers to the use of the same methods for the same items, either from
period to period within a reporting entity or in a single period across entities.
Comparability is the goal; consistency helps to achieve that goal.
QC23. Comparability is not uniformity. For information to be comparable, like
things must look alike and different things must look different. Comparability of
financial information is not enhanced by making unlike things look alike any more
than it is enhanced by making like things look different.
QC24. Some degree of comparability is likely to be attained by satisfying the
fundamental qualitative characteristics. A faithful representation of a relevant
economic phenomenon should naturally possess some degree of comparability
with a faithful representation of a similar relevant economic phenomenon by
another reporting entity.
QC25. Although a single economic phenomenon can be faithfully represented
in multiple ways, permitting alternative accounting methods for the same economic
phenomenon diminishes comparability.

Verifiability
QC26. Verifiability helps assure users that information faithfully represents the
economic phenomena it purports to represent. Verifiability means that different
knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful

5
representation. Quantified information need not be a single point estimate to be
verifiable. A range of possible amounts and the related probabilities also can be
verified.
QC27. Verification can be direct or indirect. Direct verification means verifying
an amount or other representation through direct observation, for example, by
counting cash. Indirect verification means checking the inputs to a model, formula,
or other technique and recalculating the outputs using the same methodology. An
example is verifying the carrying amount of inventory by checking the inputs
(quantities and costs) and recalculating the ending inventory using the same cost
flow assumption (for example, using the first-in, first-out method).
QC28. It may not be possible to verify some explanations and forward-looking
financial information until a future period, if at all. To help users decide whether
they want to use that information, it normally would be necessary to disclose the
underlying assumptions, the methods of compiling the information, and other
factors and circumstances that support the information.

Timeliness
QC29. Timeliness means having information available to decision makers in
time to be capable of influencing their decisions. Generally, the older the
information is, the less useful it is. However, some information may continue to be
timely long after the end of a reporting period because, for example, some users
may need to identify and assess trends.

Understandability
QC30. Classifying, characterizing, and presenting information clearly and
concisely makes it understandable.
QC31. Some phenomena are inherently complex and cannot be made easy
to understand. Excluding information about those phenomena from financial
reports might make the information in those financial reports easier to understand.
However, those reports would be incomplete and therefore potentially misleading.
QC32. Financial reports are prepared for users who have a reasonable
knowledge of business and economic activities and who review and analyze the
information diligently. At times, even well-informed and diligent users may need to
seek the aid of an adviser to understand information about complex economic
phenomena.

6
Applying the Enhancing Qualitative Characteristics
QC33. Enhancing qualitative characteristics should be maximized to the
extent possible. However, the enhancing qualitative characteristics, either
individually or as a group, cannot make information useful if that information is
irrelevant or not faithfully represented.
QC34. Applying the enhancing qualitative characteristics is an iterative
process that does not follow a prescribed order. Sometimes, one enhancing
qualitative characteristic may have to be diminished to maximize another
qualitative characteristic. For example, a temporary reduction in comparability as
a result of prospectively applying a new financial reporting standard may be
worthwhile to improve relevance or faithful representation in the longer term.
Appropriate disclosures may partially compensate for noncomparability.

The Cost Constraint on Useful Financial Reporting

QC35. Cost is a pervasive constraint on the information that can be provided
by financial reporting. Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits of reporting that information.
There are several types of costs and benefits to consider.
QC36. Providers of financial information expend most of the effort involved in
collecting, processing, verifying, and disseminating financial information, but users
ultimately bear those costs in the form of reduced returns. Users of financial
information also incur costs of analyzing and interpreting the information provided.
If needed information is not provided, users incur additional costs to obtain that
information elsewhere or to estimate it.
QC37. Reporting financial information that is relevant and faithfully represents
what it purports to represent helps users to make decisions with more confidence.
This results in more efficient functioning of capital markets and a lower cost of
capital for the economy as a whole. An individual investor, lender, and other
creditor also receive benefits by making more informed decisions. However, it is
not possible for general purpose financial reports to provide all the information that
every user finds relevant.
QC38. In applying the cost constraint, the Board assesses whether the
benefits of reporting particular information are likely to justify the costs incurred to
provide and use that information. When applying the cost constraint in developing
a proposed financial reporting standard, the Board seeks information from
providers of financial information, users, auditors, academics, and others about
the expected nature and quantity of the benefits and costs of that standard. In most
situations, assessments are based on a combination of quantitative and qualitative
information.

7
QC39. Because of the inherent subjectivity, different individuals’ assessments
of the costs and benefits of reporting particular items of financial information will
vary. Therefore, the Board seeks to consider costs and benefits in relation to
financial reporting generally, and not just in relation to individual reporting entities.
That does not mean that assessments of costs and benefits always justify the
same reporting requirements for all entities. Differences may be appropriate
because of different sizes of entities, different ways of raising capital (publicly or
privately), different users’ needs, or other factors.

This Concepts Statement was adopted by the unanimous vote of the five members
of the Financial Accounting Standards Board:
Robert H. Herz, Chairman
Thomas J. Linsmeier
Leslie F. Seidman
Marc A. Siegel
Lawrence W. Smith

The amendments in this Concepts Statement were adopted by the unanimous vote
of the seven members of the Financial Accounting Standards Board:

Russell G. Golden, Chairman

James L. Kroeker, Vice Chairman
Christine A. Botosan
Marsha L. Hunt
Harold L. Monk, Jr.
R. Harold Schroeder
Marc A. Siegel

8
APPENDIX: BASIS FOR CONCLUSIONS FOR
CHAPTER 3

Introduction
BC3.1 This basis for conclusions summarizes considerations of the Board in
reaching the conclusions in Chapter 3, Qualitative Characteristics of Useful
Financial Information. It includes reasons for accepting some alternatives and
rejecting others. Individual Board members gave greater weight to some factors
than to others.
BC3.2 The Board developed this chapter jointly with the International
Accounting Standards Board (IASB). Consequently, this basis for conclusions also
includes some references to the IASB’s literature.

Background
BC3.3 The Board began the process of developing the qualitative
characteristics of useful financial information by reviewing its own framework and
concepts as well as those of other standard setters. In July 2006, the Board
published for public comment a Discussion Paper on this topic. That same paper
also was published by the IASB. The Board and the IASB received 179 responses.
In its redeliberations of the issues on this topic, the Board considered all of the
comments received and information gained from other outreach initiatives. In May
2008, the Board and the IASB jointly published an Exposure Draft. The Boards
received 142 responses. The Board reconsidered all of the issues. This document
is the result of those reconsiderations.

The Objective of Financial Reporting and the Qualitative

Characteristics of Useful Financial Information
BC3.4 Alternatives are available for all aspects of financial reporting, including
recognition, derecognition, measurement, classification, presentation, and
disclosure. When developing financial reporting standards, the Board will choose
the alternative that goes furthest towards achieving the objective of financial
reporting. Providers of financial information also will have to choose among the
alternatives if there are no applicable standards available, or if application of a
particular standard requires judgments or options, to achieve the objective of
financial reporting.
BC3.5 Chapter 1 specifies that the objective of general purpose financial
reporting is to provide financial information about the reporting entity that is useful
to existing and potential investors, lenders, and other creditors in making decisions
about providing resources to the entity. The decision makers on which this

9
Conceptual Framework focuses are existing and potential investors, lenders, and
other creditors.
BC3.6 That objective by itself leaves a great deal to judgment and provides
little guidance on how to exercise that judgment. This chapter describes the first
step in making the judgments needed to apply that objective. It identifies and
describes the qualitative characteristics that financial information should have if it
is to meet the objective of financial reporting. It also discusses cost, which is a
pervasive constraint on financial reporting.
BC3.7 Subsequent chapters will use the qualitative characteristics to help
guide choices about recognition, measurement, and the other aspects of financial
reporting.

Fundamental and Enhancing Qualitative Characteristics

BC3.8 This chapter distinguishes between the fundamental qualitative
characteristics that are the most critical, and the enhancing qualitative
characteristics that are less critical but still highly desirable. The Discussion Paper
did not explicitly distinguish between those qualitative characteristics. The Board
made the distinction later because of confusion among respondents to the
Discussion Paper about how the qualitative characteristics relate to each other.
BC3.9 Some respondents to the Exposure Draft stated that all of the
qualitative characteristics should be considered equal and that the distinction
between fundamental and enhancing qualitative characteristics was arbitrary.
Others said that the most important qualitative characteristic differs depending on
the circumstances; therefore, differentiating among the qualitative characteristics
was not appropriate.
BC3.10 The Board does not agree that the distinction is arbitrary. Financial
information without the two fundamental qualitative characteristics of relevance
and faithful representation is not useful, and it cannot be made useful by being
more comparable, verifiable, timely, or understandable. However, financial
information that is relevant and faithfully represented may still be useful even if it
does not have any of the enhancing qualitative characteristics.

Fundamental Qualitative Characteristics

Relevance
BC3.11 It is self-evident that financial information is only useful for making a
decision if it is capable of making a difference in that decision. Relevance is the
term used in the Conceptual Framework to describe that capability. It is a
fundamental qualitative characteristic of useful financial information.

10
BC3.12 The definition of relevance in the Conceptual Framework is consistent
with the definition in FASB Concepts Statement No. 2, Qualitative Characteristics
of Accounting Information. The definition of relevance in the Framework (1989)
was that information is relevant only if it actually makes a difference in users’
decisions. However, users consider a variety of information from many sources,
and the extent to which a decision is affected by a particular economic
phenomenon is difficult, if not impossible, to determine, even after the fact.
BC3.13 In contrast, whether information is capable of making a difference in a
decision (relevance as defined in the Conceptual Framework) can be determined.
One of the primary purposes of publishing Exposure Drafts and other due process
documents is to seek the views of users on whether information that would be
required by proposed financial reporting standards is capable of making a
difference in their decisions. The Board also assesses relevance by meeting with
users to discuss proposed standards, potential agenda decisions, effects on
reported information from applying recently implemented standards, and other
matters.

Predictive and confirmatory value

BC3.14 Many decisions by investors, lenders, and other creditors are based on
implicit or explicit predictions about the amount and timing of the return on an
equity investment, loan, or other credit instrument. Consequently, information is
capable of making a difference in one of those decisions only if it will help users to
make new predictions, confirm or correct prior predictions, or both (which is the
definition of predictive or confirmatory value).
BC3.15 The Framework (1989) identified predictive value and confirmatory
value as components of relevance, and Concepts Statement 2 referred to
predictive value and feedback value. The Board concluded that confirmatory value
and feedback value were intended to have the same meaning. The Board and the
IASB agreed that both Boards would use the same term (confirmatory value) to
avoid giving the impression that the two frameworks were intended to be different.

The difference between predictive value and related statistical terms

BC3.16 Predictive value, as used in the Conceptual Framework, is not the

same as predictability and persistence as used in statistics. Information has
predictive value if it can be used in making predictions about the eventual
outcomes of past or current events. In contrast, statisticians use predictability to
refer to the accuracy with which it is possible to foretell the next number in a series
and persistence to refer to the tendency of a series of numbers to continue to
change as it has changed in the past.

11
Materiality

BC3.17 Concepts Statement 2 and the Framework (1989) discussed materiality

and defined it similarly. Concepts Statement 2 described materiality as a constraint
on financial reporting that can only be considered together with the qualitative
characteristics, especially relevance and faithful representation. The Framework
(1989), on the other hand, discussed materiality as an aspect of relevance and did
not indicate that materiality has a role in relation to the other qualitative
characteristics.
BC3.18 The Discussion Paper (July 6, 2006, FASB Preliminary Views,
Conceptual Framework for Financial Reporting: Objective of Financial Reporting
and Qualitative Characteristics of Decision-Useful Financial Reporting Information)
and the Exposure Draft (May 29, 2008, FASB Exposure Draft, Conceptual
Framework for Financial Reporting: The Objective of Financial Reporting and
Qualitative Characteristics and Constraints of Decision-Useful Financial Reporting
Information) proposed that materiality is a pervasive constraint in financial
reporting because it is pertinent to all of the qualitative characteristics. Some
respondents to the Exposure Draft agreed that any entity can consider materiality
in its reporting decisions; however, it is not a constraint on a reporting entity’s ability
to report information because the entity can choose to report immaterial
information. Furthermore, a standard setter does not consider materiality when
developing standards because it is an entity-specific consideration. As a result,
entity-specific assessments of materiality are not directly relevant to the Board’s
assessments on whether the guidance that the Board sets meets the qualitative
characteristics of financial reporting. Instead, the Board evaluates the potential
relevance of its guidance (and other qualitative characteristics of the reported
information) in the context of a broader financial reporting environment rather than
on the materiality of the information to individual entities.
BC3.18A The Board decided to continue to include a discussion of materiality in
the Concepts Statements to (a) demonstrate its understanding of the reporting
environment in which the guidance it sets is applied and (b) highlight the difference
between relevance and materiality.
BC3.18B The Board observed that the definition of materiality in this chapter as
originally issued is inconsistent with the definitions and discussions by the U.S.
Securities and Exchange Commission (SEC), auditing standards of the Public
Company Accounting Oversight Board (PCAOB) and the American Institute of
Certified Public Accountants (AICPA), and the judicial system in the United States.
That inconsistency does not help the Board to understand the environment in
which reporting entities operate. In September 2015, the Board issued proposed
Accounting Standards Update, Notes to Financial Statements (Topic 235):
Assessing Whether Disclosures Are Material, which stated that materiality is a
legal concept and that the Board observed that the U.S. Supreme Court definition
of materiality is the appropriate definition. Preparers and practitioners objected to
stating that materiality is a legal concept because it may imply that only legal

12
professionals can make materiality judgments and that materiality should be
considered an accounting concept. Others objected to the citing of the U.S.
Supreme Court definition of materiality because of its origins in antifraud litigation.
Still others stated that the meaning of the term is debatable and there is a concern
that the definition may change. Some stakeholders suggested that the definition in
Concepts Statement 21a would be a better definition. After considering the
feedback, the Board decided to replace the current definition of materiality in this
chapter with the superseded definition in Concepts Statement 2. The definition of
materiality that is in Concepts Statement 2 is quoted in SEC Staff Accounting
Bulletin No. 99, Materiality. SAB 99 notes that the definition that is in Concepts
Statement 2 is in substance identical to the definition of the U.S. Supreme Court,
which in turn results in the definition in this chapter being in substance identical to
the definition in the auditing standards of the AICPA and the PCAOB.
BC3.18C The Board decided not to incorporate all the content of the definition of
materiality from Concepts Statement 2 into this chapter. The language that was
not carried forward included, in large part, examples of how one might think about
a materiality assessment. In the Board’s view, the examples in Concepts
Statement 2 were not necessary to capture the substance of the definition.
BC3.18D The Board is aware that the discussion of materiality as amended in
this Concepts Statement is no longer identical to the definition in the International
Accounting Standards Board’s (IASB) Conceptual Framework for Financial
Reporting, though both were identical when originally issued. IAS 1, Presentation
of Financial Statements, and IAS 8, Accounting Policies, Changes in Accounting
Estimates and Errors, also include definitions of materiality. It is preferable that
both the FASB’s and the IASB’s Conceptual Frameworks converge. However, that
is not possible because (a) the IASB’s definitions of materiality are not consistent
with the definition used in the United States and (b) the IASB is working to further
amend its definitions of materiality.

Faithful Representation
BC3.19 The discussion of faithful representation in Chapter 3 differs from that
in the previous frameworks in two significant ways. First, it uses the term faithful
representation instead of the term reliability. Second, substance over form,
prudence (conservatism), and verifiability, which were aspects of reliability
in Concepts Statement 2 or the Framework (1989), are not considered aspects of
faithful representation. Substance over form and prudence were removed for the
reasons described in paragraphs BC3.26–BC3.29. Verifiability is now described
as an enhancing qualitative characteristic rather than as part of this fundamental
qualitative characteristic (see paragraphs BC3.34–BC3.36).

Superseded.
1a

13
Replacement of the term reliability

BC3.20 Concepts Statement 2 and the Framework (1989) used the term
reliability to describe what is now called faithful representation.
BC3.21 Concepts Statement 2 listed representational faithfulness, verifiability,
and neutrality as aspects of reliability and discussed completeness as part of
representational faithfulness.
BC3.22 The Framework (1989) said:

Information has the quality of reliability when it is free from material

error and bias and can be depended upon by users to represent faithfully
that which it either purports to represent or could reasonably be expected
to represent.

The Framework (1989) also discussed substance over form, neutrality, prudence,
and completeness as aspects of faithful representation.
BC3.23 Unfortunately, neither framework conveyed the meaning of reliability
clearly. The comments of respondents to numerous proposed standards indicated
a lack of a common understanding of the term reliability. Some focused on
verifiability or free from material error to the virtual exclusion of faithful
representation. Others focused more on faithful representation, perhaps combined
with neutrality. Some apparently think that reliability refers primarily to precision.
BC3.24 Because attempts to explain what reliability was intended to mean in
this context have proven unsuccessful, the Board sought a different term that
would more clearly convey the intended meaning. The term faithful representation,
the faithful depiction in financial reports of economic phenomena, was the result of
that search. That term encompasses the main characteristics that the previous
frameworks included as aspects of reliability.
BC3.25 Many respondents to the Discussion Paper and the Exposure Draft
opposed the Board’s preliminary decision to replace reliability with faithful
representation. Some said that the Board could have better explained what reliable
means rather than replacing the term. However, many respondents who made
those comments assigned a different meaning to reliability from what the Board
meant. In particular, many respondents’ descriptions of reliability more closely
resembled the Board’s notion of verifiability than its notion of reliability. Those
comments led the Board to affirm its decision to replace the term reliability with
faithful representation.

Substance over form

BC3.26 Substance over form is not considered a separate component of faithful

representation because it would be redundant. Faithful representation means that

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financial information represents the substance of an economic phenomenon rather
than merely representing its legal form. Representing a legal form that differs from
the economic substance of the underlying economic phenomenon could not result
in a faithful representation.

Prudence (conservatism) and neutrality

BC3.27 Chapter 3 does not include prudence or conservatism as an aspect of

faithful representation because including either would be inconsistent with
neutrality. Some respondents to the Discussion Paper and Exposure Draft
disagreed with that view. They said that the framework should include
conservatism, prudence, or both. They said that bias should not always be
assumed to be undesirable, especially in circumstances when bias, in their view,
produces information that is more relevant to some users.
BC3.28 Deliberately reflecting conservative estimates of assets, liabilities,
income, or equity sometimes has been considered desirable to counteract the
effects of some management estimates that have been perceived as excessively
optimistic. However, even with the prohibitions against deliberate misstatement
that appear in the existing frameworks, an admonition to be prudent is likely to lead
to a bias. Understating assets or overstating liabilities in one period frequently
leads to overstating financial performance in later periods—a result that cannot be
described as prudent or neutral.
BC3.29 Other respondents to the Exposure Draft said that neutrality is
impossible to achieve. In their view, relevant information must have purpose, and
information with a purpose is not neutral. In other words, because financial
reporting is a tool to influence decision making, it cannot be neutral. Obviously,
reported financial information is expected to influence the actions of users of that
information, and the mere fact that many users take similar actions on the basis of
reported information does not demonstrate a lack of neutrality. The Board does
not attempt to encourage or predict specific actions of users. If financial information
is biased in a way that encourages users to take or avoid predetermined actions,
that information is not neutral.

Can faithful representation be empirically measured?

BC3.30 Empirical accounting researchers have accumulated considerable

evidence supporting relevant and faithfully represented financial information
through correlation with changes in the market prices of entities’ equity or debt
instruments. However, such studies have not provided techniques for empirically
measuring faithful representation apart from relevance.
BC3.31 Both previous frameworks discussed the desirability of providing
statistical information about how faithfully a financial measure is represented. That
would not be unprecedented. Other statistical information is sometimes reflected

15
in financial reports. For example, some entities disclose value at risk from
derivative financial instruments and similar positions. The Board expects that the
use of statistical concepts for financial reporting in some situations will continue to
be important. Unfortunately, the Boards have not identified any way to quantify the
faithfulness of the representations in a financial report.

Enhancing Qualitative Characteristics

Comparability
BC3.32 Comparability was an important concept in both Concepts Statement 2
and the Framework (1989), but the two previous frameworks disagreed on its
importance. Concepts Statement 2 described comparability as a quality of the
relationship between two or more pieces of information that, although important, is
secondary to relevance and faithful representation. The Framework (1989) stated
that comparability is as important as relevance and faithful representation. 2
BC3.33 Relevant and faithfully represented information is most useful if it can
be readily compared with similar information reported by other entities and by the
same entity in other periods. One of the most important reasons that financial
reporting standards are needed is to increase the comparability of reported
financial information. However, even if it is not readily comparable, relevant and
faithfully represented information is still useful. Comparable information, however,
is not useful if it is not relevant and may mislead if it is not faithfully represented.
Therefore, comparability is considered an enhancing qualitative characteristic
instead of a fundamental qualitative characteristic.

Verifiability
BC3.34 Verifiable information can be used with confidence. Lack of verifiability
does not necessarily render information useless, but users are likely to be more
cautious because there is a greater risk that the information does not faithfully
represent what it purports to represent.
BC3.35 The Framework (1989) did not explicitly include verifiability as an
aspect of reliability, but Concepts Statement 2 did. However, the two frameworks
are not as different as it might appear because the definition of reliability in the
Framework (1989) contained the phrase and can be depended upon by users,
which implies that users need assurance on the information.
BC3.36 The Discussion Paper stated that reported financial information should
be verifiable to assure users that it is free from material error and bias and can be
depended on to represent what it purports to represent. Therefore, verifiability was

2
The term reliability was used instead of faithful representation, but the meaning was
intended to be similar.

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considered an aspect of faithful representation. Some respondents pointed out that
including verifiability as an aspect of faithful representation could result in
excluding information that is not readily verifiable. Those respondents recognized
that many forward-looking estimates that are very important in providing relevant
financial information (for example, expected cash flows, useful lives, and salvage
values) cannot be verified directly. However, excluding information about those
estimates would make the financial reports much less useful. The Board agreed
and repositioned verifiability as an enhancing qualitative characteristic, very
desirable but not necessarily required.

Timeliness
BC3.37 Concepts Statement 2 described timeliness as an aspect of relevance.
The Framework (1989) discussed timeliness as a constraint that could rob
information of relevance. However, the substance of timeliness as discussed in
the two previous frameworks was essentially the same.
BC3.38 The Discussion Paper described timeliness as an aspect of relevance.
However, some respondents pointed out that timeliness is not part of relevance in
the same sense that predictive and confirmatory value are. The Board was
persuaded that timeliness is different from the other components of relevance.
BC3.39 Timeliness is very desirable, but it is not as critical as relevance and
faithful representation. Timely information is useful only if it is relevant and faithfully
represented. In contrast, relevant and faithfully represented information may still
be useful (especially for confirmatory purposes) even if it is not reported in as
timely a manner as would be desirable.

Understandability
BC3.40 Both Concepts Statement 2 and the Framework (1989) included
understandability, a qualitative characteristic that enables users to comprehend
the information and therefore make it useful for making decisions. Both frameworks
also similarly described that for financial information to be understandable, users
should have a reasonable degree of financial knowledge and a willingness to study
the information with reasonable diligence.
BC3.41 Despite those discussions of understandability and users’
responsibilities for understanding financial reports, misunderstanding persists. For
example, some have expressed the view that a new accounting method should
not be implemented because some users might not understand it, even though the
new accounting method would result in reporting financial information that is useful
for decision making. They imply that understandability is more important than
relevance.

17
BC3.42 If understandability considerations were fundamental, it might be
appropriate to avoid reporting information about very complicated things even if
the information is relevant and faithfully represented. Classifying understandability
as an enhancing qualitative characteristic is intended to indicate that information
that is difficult to understand should be presented and explained as clearly as
possible.
BC3.43 To clarify another frequently misunderstood point, the Conceptual
Framework explains that users are responsible for actually studying reported
financial information with reasonable diligence rather than only being willing to do
so (which was the statement in the previous frameworks). In addition, the
Conceptual Framework states that users may need to seek the aid of advisers to
understand economic phenomena that particularly are complex.

Qualitative Characteristics Not Included

BC3.44 Transparency, high quality, internal consistency, true and fair view or
fair presentation, and credibility have been suggested as desirable qualitative
characteristics of financial information. However, transparency, high quality,
internal consistency, true and fair view or fair presentation are different words to
describe information that has the qualitative characteristics of relevance and
representational faithfulness enhanced by comparability, verifiability, timeliness,
and understandability. Credibility is similar but also implies trustworthiness of a
reporting entity’s management.
BC3.45 Interested parties sometimes suggested other criteria for standard-
setting decisions, and the Board has at times cited some of those criteria as part
of the rationale for some decisions. Those criteria include simplicity, operationality,
practicability or practicality, and acceptability.
BC3.46 Those criteria are not qualitative characteristics. Instead, they are part
of the overall weighing of benefits and costs of providing useful financial
information. For example, a simpler method may be less costly to apply than a
more complex method. In some circumstances, a simpler method may result in
information that is essentially the same as, but somewhat less precise than,
information produced by a more complex method. In that situation, a standard
setter would include the decrease in faithful representation and the decrease in
implementation cost in weighing benefits against costs.

The Cost Constraint on Useful Financial Reporting

BC3.47 Cost is a pervasive constraint that standard setters, as well as
providers and users of financial information, should keep in mind when considering
the benefits of a possible new financial reporting requirement. Cost is not a

18
qualitative characteristic of information. It is a characteristic of the process used to
provide the information.
BC3.48 The Board has attempted and continues to attempt to develop more
structured methods of obtaining information about the cost of gathering and
processing the information that proposed standards would require entities to
provide. The primary method used is to request interested parties, sometimes
formally (such as by field tests and questionnaires), to submit cost and benefit
information for a specific proposal that is quantified to the extent feasible. Those
requests have resulted in helpful information and have led directly to changes to
proposed requirements to reduce the costs without significantly reducing the
related benefits.

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